U.S. GENERAL ACCOUNTING OFFICE

WASEINGTON, D.C. 20548

FOR RELEASE ON DELIVERY EXPECTED AT 10:00 A.M.

+UESDAY. OCTOBER 26, 1983 us. - STATEMENT OF

WARREN G. REED DIRECTOR

INFORMATION MANAGEMENT AND TECHNOLOGY DIVISION UNITED STATES GENERAL ACCOUNTING OFFICE

BEFORE THE 1111111111111 Ill 122681

COMMITTEE ON ARMED SERVICES,

UNITED STATES SENATE,

ON

DEPARTMENT OF DEFENSE SPARE PARTS

PROCUREMENT PRACTICES

Mr. Chairman and Members of the Committee:

We are pleased to be here today at your hearing on the

Department of Defense's spare parts procurement practices. In

an August 8, 1983, letter to us, you expressed concern that the

Defense Department may not be realizing the full benefit of modern

computer capabilities to manage the procurement process. You

asked us to look at the computer equipment and software that sup-

port procurement activities used in purchasing aircraft spare

parts. You also asked that we focus our work on computer genera-

ted information being used to identify unwarranted spare parts

price increases.

We performed our work at the locations you identified--the

Air Force's San Antonio Air Logistics Center in Texas, the Navy's

Aviation Supply O ffice and the Defense Industrial Supply Center,

both in Philadelphia, and the Army's Aviation Materiel Readiness

Command in St. Louis. At these locations we interviewed officials

working in procurement and data automation and reviewed various

contract files and planned improvements in automation. We also

interviewed officials on the various Defense Department task for-

ces investigating spare parts pricing and procurement problems.

Our overall assessment (slide l), based on the short time we

had to perform the work, is that (1) computer equipment is or soon

will be technologically current: (2) computer software programs,

with the exception of the Army's, are logically and technically

outdated: (3) computer based information provided officials for

buying aircraft engine spare parts is limited; and (4) computer

capabilities being used to identify and prevent unwarranted price

increases range from limited to none.

I would like to stress that because of time constraints, we

are not making specific recommendations. However, I will offer

for consideration improvements that can be made which I will dis-

cuss later. Before I discuss the specific areas we focused on, I

would like to briefly explain how our work fits into the overall

wholesale logistics function.

As you can see (slide 2), wholesale logistics requires inter-

action between its various functional subsystems--Stock Control,

Requirements, Financial Management, Provisioning, Technical and

Cataloging, and Contracting.

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When it receives a customer's requisition, Stock Control

searches its records to determine if the spare part is a stocked

or a non-stocked item. If stocked and available, Stock Control

'directs shipment of the part to the customer and the usage is re-

ported for historical purposes. If the spare part is not routine-

ly ,stocked, Stock Control passes a request to Contracting for item

procurement. Also, at this time, Requirements evaluates the (1)

usage history of the non-stocked spare part, (2) usage forecasts,

and (3) budget information to decide whether the spare part should

be stocked to meet future demands.

If the spare part is a stocked item but available quantities

cannot meet the customer's need, Requirements decides whether to

proceed with a procurement or to delay purchase of the spare part

because of lack of funds, higher priority needs, etc. An item

manager, in Requirements, on the basis of a computer generated

supply study, makes this decision. Both Stock Control and

Requirements routinely use the computer for these operations.

Once the item manager makes a buy decision, the computer aids

in preparing a purchase request which is sent to Contracting. At

this time, the buyer receives several documents, such as the pur-

chase authorization, historical pricing,data, and a bidders list.

As I will discuss later, the use of the computer to produce these

as well as other solicitation documents varies among the services.

This is the area where we focused our audit work.

When technical and engineering drawings are needed for compe-

titive spare parts procurements, Technical and Cataloging provide

a package containing specifications, drawings, dimensions, etc.

3

Other functions technical and cataloging perform include evalu-

ating available technical engineering data to determine what spare

parts substitutes are acceptable and what spare parts, provided by

a prime contractor, can and should be competitively bought. These

are basically manual functions.

Financial Management records financial obligations and com-

mitments, assures that needed funds are available, and bills cus-

tomers when the ordered spare parts are provided. This is mostly

a computerized function.

Provisioning, the last wholesale logistics function, uses

initial forecasting information to make stock versus non-stocked

spare parts decisions and to establish initial stockage levels.

Provisioning also decides (1) whether to buy the spare parts tech-

nical data and (2) how the initial spare parts should be bought.

This is a manual intensive operation.

Now I would like to address the questions in your letter.

Our comments on the computer and software programs focus on sup-

port of the overall logistics functions. Our comments on computer

based information relate to contracting.

On the question of age, capability, and operating condition

of the computers (slide 3), the Army's, Air Force's, and the

Defense Logistics Agency's computers are of relatively current

technology. The Navy's computers are old and technologically

dated. The Navy plans to award a contract for new computer

equipment in January 1984 with the first delivery in April 1984.

The Army's computers were installed in 1980 and 1981 and were up-

graded in 1982. The Defense Logistics Agency's and the Air

4

Force's computers were installed in 1982 and 1983. These com-

puters are an interim step until major computer replacement pro-

curements can be completed. The Defense Logistics Agency's

procurement is underway with completion estimated to be in 1986.

The Air Force has just started and is now in the planning stage.

For these reasons, we believe the computer equipment the services

are using to support their wholesale logistics operations is or

will be current.

Regarding the computer

overall wholesale logistics

age and effectiveness, with

software programs that support the

operations (slide 4), we believe their

the exception of the Army's, are logi-

cally and technically out dated and that improvements can and

should be made. The Army's computer software programs were devel-

oped in the early 1970s and operate as an integrated system. Al-

though the Army must continually refine its programs to improve

their effectiveness, it does not plan a major redesign at this

time. The Defense Logistics Agency, along with replacing its com-

puters, plans a major redesign of the software.

The Air Force's and the Navy's computer software programs are

a collection of independent programs. Data processed by these

computer programs must be collected, sorted, and then sequentially

processed. Thus, updating data and correcting errors is a time-

consuming process. These processing techniques reflect computer

capabilities that were prevalent in the early 1960s. The Navy, as

part of the new computer acquisition I mentioned earlier, expects

to complete a major software redesign effort by 1989, and the Air

Force has developed a software improvement program. Because of

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our short timeframe, we did not evaluate any of these planned com-

puter software redesign or improvement efforts. This concludes my

computer equipment and software status report on how the overall

wholesale logistics operations are currently being supported.

Now I would like to turn to the results of our work on com-

puter generated information provided to the buyer. Referring to

the slide (slide 5), I ask you to recall that the buyer's role is

one of many in the overall logistics process.

The next slide (slide 6) shows the basic functions performed

by the buyer and the information available--automated and manual.

The process is shown as beginning on the left and moving to the

right. The shaded areas represent computer generated input to the

buyer and the half shaded areas indicate there are some manual

processes that must be completed by the buyer in some services.

As we see it, in competitive procurements, the buyer has two

major decision points. The first includes reviewing the procure-

ment package and selecting contractors who will be asked to make a

bid. The second involves evaluating the bids received against

certain criteria and selecting a contractor. We have included, as

represented by the dotted line, a decision function unique to some

of the services. Using a remote terminal, the buyer can access

the computer to get additional information on other purchase re-

quests for the same item. This allows the buyer to consolidate

the purchase requests and perhaps obtain lower prices per item by

buying in larger quantities. We found instances where the buyers

did not consolidate multiple purchase requests for the same item.

I will discuss these later.

For sole source procurements, although the number of docu-

ments provided to the buyer are less, the process is equally rele-

vant. The buyer must still review the documentation for complete-

ness. However, there may be instances where the buyer knows other

sources of supply and can question the need for a sole source pro-

curement.

The next slide (slide 7) identifies computer based informa-

tion provided to the buyer. The first is the Purchase Authoriza-

tion which is the buyer's notice and authority to begin the

contracting process. The next three --Procurement History, Bidders

List, and Contract-- are tools available to the buyer to complete

the contracting process. The last-- Price Variance Report--is a

management tool that can be used to identify spare parts price

increases that should be investigated.

I will now discuss each of these in detail. All the services

have a Purchase Authorization document that the computer produces.

Most describe what is being bought but the Navy's does not. For

example, looking at the next slide (slide 8), I'd like to see if

any of you can identify what is being ordered? Do you know what

it is? What it might look like? If so, can you estimate how much

it should cost? The item being bought by the Navy is an "actu-

ating ring" used to control air intake into an aircraft engine and

costs about $2,000.

The next document, Procurement History, is one of the tools

the buyer has available for completing the contract. It contains

such information as prior contracts awarded, and other related in-

formation. The number of prior contracts and other information

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varies by service. For example, the can Navy identify contracts

awarded in the last 10 years and the Air Force identifies con-

tracts awarded in the last 3 years. The Army can provide informa-

tion on up to the last 10 contracts and the Defense Logistics

Agency up to the last 6 contracts. For the Army and the Defense

Logistics Agency, this means that if all the buys were made in the

last year, only that year of procurement history would be pro-

vided. Adding more procurement history information would give the

buyer a longer price trend line and assist him in making the re-

quired "fair and reasonable" price determination.

The Bidders List is the next tool the buyer has available for

completing the contracting process. Not all the services have an

automated Bidders List and not all buyers automatically receive

one for every purchase. The Navy's Bidders List is a manual com-

pilation by each buyer of known bidders identified through the

buyer's own past efforts and experiences. The Army does not auto-

matically generate a Bidders List for the buyer on purchases less

than $25,000. The buyer must specially request that one be pro-

vided.

The Defense Logistics Agency Bidders List identifies the

names and addresses of bidders. The Army gives the same informa-

tion, plus phone numbers, if available, and other coded infor-

mation on the contractor. The Air Force's Bidders List gives the

buyer the most information.

Automated Contracts are another tool the buyer has for com-

pleting the contracting process. To a degree, all services have

some form of automated contracts. The Army and the Defense

8

Logistics Agency have automated contracts for small purchases--the

Army less than $25,000 and Defense Logistics Agency less than

$10,000. The Air Force and the Navy have automated contracts for

all purchases, but the Navy automates only certain portions of the

contract. The buyer must make manual entries and tailor the re-

maining portions of the contract before it is sent out for repro-

duction.

The final document, the Price Variance Report, can be a buyer

and management control tool for identifying spare parts price in-

creases that exceed parameters set by management. The Defense

Logistics Agency is the only organization that uses the computer

to report spare parts price increases. However, this report is

limited to contracts of less than $1,000. All but one Defense

Logistics Agency supply center identifies and reports price in-

creases greater than 25 percent or $25. The Defense Industrial

Supply Center uses 50 percent or $35.

The next slide (slide 9) shows an example of the Defense

Logistics Agency's Price Variance Report. Note that the report

shows that the current price of $7.65 versus $.71 which was the

lowest price paid for the item over the last 12 months. This is

more than a 10 fold increase, greatly exceeding the 50 percent

management criteria used at the Defense Industrial Supply Center.

This particular item is a "retainer ring", similar to a washer.

We are showing you this to emphasize how the computer can assist

management by flagging price increases. The next slide (slide 10)

summarizes what I have told you the services have now.

9

Now that I have discussed and shown you the computer based

tools given the buyer for contracting for spare parts, I would

like to go over two examples of spare parts procurements that

could have been done better if more automated information had been

provided or the buyer had made better use of available informa-

tion. However, I'd like to emphasize that these are just examples

of what we observed happening and are not intended to indicate

widespread problems.

My first example is an Army procurement of a frame assembly

(slide 11). Observe that in the upper right corner of the Pro-

~ curement Work Directive for buyer 1 and 2, both procurements were

started in May 1983 within 8 days of each other. On the procure-

ment started on May 20, right side of the slide, the procurement

directive told the buyer that the first buy was still unawarded.

This information is provided so multiple buys for the same item

can be consolidated whenever possible.

The points of this example are:

--The procurement authorization document pointed out that the

first procurement was still in process but neither buyer

made any effort to coordinate and consolidate the two buys.

Both buyers were on the same 4-person buying team and sat

within 30 feet of each other.

--Neither buyer was provided or requested an Bidders List and

both used personally maintained "cuff records" to identify

contractors.

--Two different buyers selected different contractors as pot-

ential sources. Buyer number one solicited 5 contractors,

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but only listed 3, and received 1 bid for $410. Buyer num-

ber two solicited nine contractors and received bids from

seven (slide 12). The lowest bid received by buyer two was

for $139.60. Each buyer ended up with two different

prices--$139.60 and $410.00-a difference of $270.40. As

an aside, I would like to point out that one of the con-

tractors canvassed by buyer number one and number two were

the same. Interestingly enough, this contractor proposed

different prices to each buyer-- for the quantity of 6 the

price was $410 and for 20 the price was $435. The Army has

no price variance reporting capability to identify these

types of price differences, but it is developing such a

reporting capability.

These two contracts were awarded on the same day in July 1983, for

the same item, for unit prices that differed by $270.40, and by

the same contracting officer (slide 13).

Our next example is of an Air Force procurement of a door

seal retainer for the C-5 aircraft. On the procurement history

(slide 14), left side, is a number that indicates there was

another purchase request for the same item being processed. The

other number, 6WR, specifically identifies the first buyer. When

the second buyer received a proposed price of $188 per unit and

compared it to the $130 cost on the procurement history, the buyer

questioned the contractor about the new higher price. The buyer

was told it was an "extrusion" product that had to have holes

drilled in it. Therefore, with only limited data to question the

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price, the buyer accepted Lockheed's "Certification of Data in

Support of Proposal Price Breakdown". This certification stated:

Planning and tooling $ 1.06

Production 13.75

Quality assurance 1.21

Material and parts pur-.

chased or subcontracted 121.54

Total factory unit cost $137.56

To this total, allowable expenses and profits of about $50.00 were

added for a total selling price of $188.06. Although shown on the

certification as $188.95, the Air Force was able to negotiate away

the 89 cents difference.

The points of this example are:

--This spare part was bought on a sole source basis and the

technical drawings are proprietry. Therefore, competition

was precluded.

--Two procurements were in process at the same time for the '

same item, and were not coordinated or consolidated.

--The first buyer's contract, for a quantity of 22, was

awarded at a unit price of $77.67. The second buyer's

contract, for a quantity of 29, was awarded at a unit price

of $188.06 (slide 15). This is $110.39 more than the first

buyer's contract which was for a quantity of 22 each.

--The buyers had no idea that what was being bought was a

standard strip of "extruded" aluminum alloy about 14 inches

low I 5/8 inches wide with 7 attaching holes drilled in it.

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--Air Force technical engineers examined this part and con-

cluded that it can be fabricated at a unit cost of $6.81

when 25 are made and $4.62 for 400. These engineers stated

that no special testing requirements were needed because

the part is not a fatigue critical item.

In response to an Air Force inquiry on this spare part,

Lockheed's October 10, 1983, letter states the quote for $188.06

was "correct for pricing policies at that time, but was higher

than normal as a result of a minimum buy of peculiar raw material

that was not carried in stock. Total procured material was priced

into this contract." This means Lockheed purchased 4,260 feet of

aluminum and allocated the cost to the 29 parts being ordered by

the Air Force. We were told by Air Force engineers that the

aluminum is available in 10 foot lengths at a cost of $2.70 per

length. Lockheed's newly adjusted price per unit is $32.00. This

new price is about $25.00 more than Air Force engineers conclude

that a quantity of 25 "should cost".

I'd like to reemphasize that these are examples of what we

observed happening in the contracting process and are not intended

to indicate widespread problems.

Now I'd like to tell you about some of the actions that the

services are taking to help the buyer do a better job and to

achieve lower spare parts prices (slide3 16).

For the Purchase Authorization you see several areas where

two dashes are entered. This indicates no action is needed or is

being taken to improve the Procurement Authorization documents and

is not necessarily a deficiency. However, note that the Army is

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taking some action to improve its spare parts procurement plan

ning. On Procurement History, the Navy is including more informa-

tion on contractor practices. The Air Force is developing a value

engineering "should cost" capability to determine what the Air

Force should expect to pay for the spare parts and to print this

on the procurement history. On the Bidders List, each service has

started or plans action to increase competition by identifying

additional contractors they can call on to provide needed spare

parts. Reading across note that the Navy is increasing the empha-

sis on competitive awards and the other services are appointing

competition advocates. With automated contract documentation,

note the Army and Navy are restricting use of unpriced orders.

Restricting unpriced orders reduces the number of spare parts that

can be ordered without knowing what their actual costs will be.

Lastly, on price variances, the Army is developing a price vari-

ance reporting capability. We agree these efforts are a step in

the right direction, but more can be done and we offer some areas

for consideration.

As we see it, the buyer has many tasks where the computer can

help improve productivity, increase competition, and help the buy-

er identify price increases for review (slide 17).

Beginning with the Procurement History, this document could

include computer-based information giving (1) the "should cost"

data, (2) technical data in "layman" terms, (3) contractor and

item profile information, and (4) alternative quantity analysis

results. Because alternative quantity analysis is also suggested

for Automated Contract Documentation, I will discuss it later.

14

The "should cost" information, or putting it another way,

intrinsic value of the item, would provide the buyer a technical

basis for assessing the reasonableness of contractor proposed

prices. Technical data in wlaymanw terms would help the buyer

understand what is being bought and what production cost factors

might influence a contractor's proposed price. Contractor and

item profile information would provide the buyer information on

the contractor's past performance, prior pricing, negotiating

practices, and cost information on items similar to the one being

procured.

The next area for consideration relates to the Bidders List.

They would help foster competition and expand the buyer's know-

ledge'of the marketplace. In his July 25, 1983, memo on "Spare

Parts Procurement 10 Point Program", Secretary of Defense

Weinberger stated that all of the services had a competition advo-

cate in each buying command. However, we found that all the ser-

vices do not have one in place. This may be because the program

is relatively new. We don't know if a competition advocate is

needed but we do believe market research techniques should be em-

phasized. Such techniques could include identifying new sources

of supply, that would then be placed in the computer and used for

expanding the number of contractors listed on the Bidders List.

Also, we believe that a Bidders List should be provided to the

buyer for every competitive procurement--regardless of dollar

value. If a Bidder List had been given to the two Army buyers in

our example, it may have been prevented them from contracting for

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the same item on the same day from two different contractors at

prices that differed by about $270.

The areas for consideration that support Automated Contract

Documentation are (1) automating the buyer's need to analyze con-

tractor proposed cost factor analysis, (2) increasing the use of

the computer for preparing solicitation and contract documents,

and (3) using the computer to analyze alternative quantity propos-

als. The Navy recently developed a computerized mathematical

model for analyzing contractor proposed cost factor changes, such

~ as new labor rates, overhead, etc. Before this model was devel-

w-L it took Navy buyers 3 to 4 hours to manually determine the

"bottom line" effect of any contractor proposed change. Now,

using a computer, the buyer can get the results in a matter of

minutes. Another area where the computer could be used is to

reduce the buyer's administrative tasks. The computer could pre-

pare more of the solicitation and contract documents for all types

of procurements.

Finally, we believe the government should encourage contrac-

tors to offer alternative quantities. Current contracting provi-

sions permit the government to do this. Thus, contractors could

offer alternative quantities at varying unit prices that would

reflect their production economies of scale. However, in many in-

stances, the quantities requested are so small they limit the con-

tractor's ability to recover costs. If encouraged to do so, we

believe contractors would propose alternative quantities and

prices and the computer could be used to analyze the various pro-

posals that are received. The buyer could then make an informed

16

buy decision on quantity and cost --within procurement funding par-

ameters. Looking at the slide (slide 18), you can visualize how

increased production quantities should result in lower unit

prices.

Now I would like to turn to the area that has received a

great deal of attention --unwarranted spare parts prices. We

believe the computer can be useful in identifying potential unwar-

ranted price increases by reporting (1) price variances and (2)

"should cost" information.

As I mentioned earlier, computer-based price variance report-

ing is currently limited to the Defense Logistics Agency's small

purchases that are less than $1,000. However, the Army is devel-

oping a price variance reporting capability and procedures to re-

quire the buyer to justify price increases that are greater than

25 percent. We believe such automated reporting capabilities for

all services and for all procurements would help buyers and mana-

gers flag price increases that should be analyzed to determine if

the increase is unwarranted.

* * * * * * *

To summarize, you asked us to look at the computer equipment

and software that support procurement activities and to focus our

work on computer generated products being used to identify unwar-

ranted price increases. We did that (slide 19), and our overall

17

assessment is (1) the computers are or will be technologically

current; (2) the software, with one exception, is outdated; (3)

the computer-generated products and information for procurement

officials to use are limited; and (4) the computer capabilities

designed to identify and prevent unwarranted price increases range

from limited to none. We have also discussed the services' ef-

forts to improve the procurement of spare parts and identified

areas where we believe automation could help the buyer before,

during, and after contracting (slide 20). These computer-based

changes can increase the buyer's productivity, expand spare parts

competition, and help identify unwarranted price increases. To

the extent that our considerations are not already a part of soft-

ware improvements planned by the services, we believe they should

be.

Mr. Chairman, I remind you that the area we looked at to res-

pond to your request is but a small segment in the overall logis-

tics process. Many of these functions, where more work needs to

be done, also affect pricing.

GAO's new division, the Information Management and Technology

Division, was formed in July of this year and is responsible for

GAO work in computers, information technology, and communications.

Its Defense Logistics Systems group is now identifying and

planning its audit priorities for the next several years. Al-

though we believe the computer offers many opportunities for

making significant improvements, even the most modern computers

and software cannot substitute.for effective buyer practices, as

our two examples have illustrated. Contracting officers and

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buyers are oriented to support military requirements and buyers

work for contracting officers. In other GAO reviews on spare

parts procurement we are finding that buyers are being rated on

their ability to award large numbers of contracts and not on their

actions to prevent or resolve unwarranted spare parts price in-

creases.

While we agree that productivity is important, we believe

pricing reviews and attention to suspected over-pricing should be

considered when the buyer's performance is being evaluated.

This concludes my testimony. I am ready to answer questions

you may have.

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